Wednesday, December 17, 2008

What'll be big in 2009?

CommSec's Craig James presents his list:

"Each year we attempt to identify the Big Issues for the coming year. There is no doubt that the US-originated global financial crisis was the issue of 2008. But what will dominate in 2009?

CommSec identified recession as being one of the Big Issues for 2008. Unfortunately we were right and recession will again be a dominant issue for at least the first half of 2009. However CommSec believes that economic recovery will take over as the principal focus over the second half of 2009. Other key themes in 2009 are likely to include infrastructure spending, rising unemployment, monetary policy and emissions trading. As always, China will never be too far from investor thoughts over 2009"...

The Big Issues Of The Past Year

At the beginning of 2008 the US sub-prime crisis was occupying attention on financial markets. But no one predicted just how aggressively it would overwhelm financial markets over the year, dragging down otherwise healthy economies and producing recessions in many parts of the globe.

The tragedy is that the sub-prime crisis – which became the Global Financial Crisis – again reflected failures by authorities in the world’s largest economy – the United States – causing global economies to weaken and drying up sharemarket wealth.

The key economic and financial issues of 2008 have all flowed from the Global Financial Crisis. Namely, recessions in major economies (barring Australia), massive falls on global sharemarkets, interest rates hitting record lows and a sharp appreciation of the US dollar against major currencies.

The scale of the falls on global sharemarkets is highlighted by the fact that the Australian sharemarket is on track to record its largest calendar year decline. The 45 per cent slide for the All Ordinaries compares with a 33.9 per cent fall in 1930.

One of the only positives to have come out from the crisis is that inflation rates have dramatically eased. Reduced demand by consumers and businesses for goods has translated to less demand for raw materials or commodities, notably oil. And slower consumer spending has meant more discounting by businesses.

The most remarkable aspect of the Global Financial Crisis has been the speed which it has enveloped the globe. In July, commodity prices were at record highs with oil almost US$150 a barrel, central banks were fretting about rising inflation, labour markets across the globe were tight and there were fears of overheating in China.

But five months later, oil is nearer US$45 a barrel, deflationary fears have replaced concerns about high inflation, labour markets have weakened and there are worries about a ‘growth recession’ emerging in China.

The reaction highlights the power of globalisation as well as the role that fear can play in shaping financial markets and economies. Fear caused banks to stop lending to one another. And fear caused investors to stop buying shares, opting for the relative safety of cash-based investments.

Consumers responded to sharp falls on global sharemarkets by scaling back spending on discretionary purchases. And the same cautious attitude was expressed by businesses in hiring and investment plans. Central banks were forced to aggressively cut interest rates while governments unveiled major stimulus packages.

Remarkably it took just 74 days for the Australian dollar to slide from US98 cents to US62 cents. The speed of the decline reflected similar sharp falls on commodity markets as large fund managers and hedge funds took the view that the five year commodity boom was over. At the same time, US businesses withdrew investments from all parts of the globe, buoying the greenback and, in turn, causing major currencies to slump.

The Big Issues for 2009

What will be the issue of the year?

As always, this is the most contentious question and invariably one that most analysts get wrong. And that’s because there is always something that comes from left field and ends up becoming the dominant influence. Last year we listed a raft of issues that we thought would dominate in 2008 like recession, labour shortages and climate change. In the end we opted for climate change, believing that there was a sufficient groundswell of community support to force action by major global economies. However a combination of international inaction and the growing Global Financial Crisis saw climate change issues pushed to the background.

While the sub-prime crisis was a key threat to the US economy in late 2007, at the same time commodity prices were still marching higher, driven by the strength of economies in Asia – especially China and India. The perception was that the sub-prime issue was containable with no one envisaging a scenario that US investment banks would fail or would have to be rescued. If anyone suggested that all US investment banks would cease to exist by end year they would have been quickly wrapped up in a tight white suit.

Looking ahead to 2009, we would be reticent about identifying one issue that will dominate over the year. Rather we think recession will be the dominating issue early in 2009, giving way to economic recovery over the second half of the year. A key influence will be confidence. While central banks have slashed interest rates and governments are pumping money into economies, no one can make consumers spend or businesses invest or hire workers.

In the US, past recessions have tended to end around 2-3 months before employment turns positive. So we would expect that the current recession will end around mid 2009, putting it on par with the 1973-75 downturn that lasted 16 months.

In Australia, we still believe that recession will be avoided but it will be a close run thing. Still, a raft of stimulus factors such as lower petrol prices, falling interest rates, increased Government spending and the expanded first home owners grant will all be working to lift activity over the coming year.


Increased spending on economic and social infrastructure is emerging as a key theme for 2009. In Australia, the Federal Government will unveil the priority list of infrastructure projects for the Government’s $24 billion Building Australia Fund in early 2009. Projects like expansion of port facilities and enhancement of rail networks will be important to ensure Australia meets China’s demand for resources in coming years. But at the same time, Australia’s growing population is stretching demands on social infrastructure such as schools and hospitals. The average age of the Government’s capital stock has risen from around 17 years to almost 23 years.

In the US, infrastructure spending has also been identified by President-elect Obama as a priority issue in 2009. Not only is there an urgent need to upgrade the country’s ageing infrastructure but the projects will be important in dragging the economy out of recession and kick starting growth. The American Society of Engineers estimated a year ago that it would take US$1.6 billion spent over five years to improve US roads, dams and bridges.

And in other countries like China, again infrastructure will be a priority area in 2009. On November 9, the Chinese Government announced a 4 trillion Yuan stimulus package ($870 billion) focused in “10 key areas such as low-income housing, rural infrastructure, water, electricity, transportation, the environment, technological innovation and rebuilding from several disasters, most notably the May 12 earthquake.”

President Obama

It may appear odd to represent US President-elect Barack Obama on the list of big economic issues for 2009. But when it comes to identifying key influences on economic activity, the incoming President’s role will be vital. Not only is President-elect Obama in the process of devising an economic stimulus plan, but he is seen as a major catalyst in boosting confidence levels.

The assumption of power by President Obama could prove similar to the influence the second Gulf War had in sparking revival on the sharemarket. Back in March 2003 the 4½ year sharemarket bull run commenced when allied forces embarked on the second Gulf War. Uncertainty about whether conflict would occur had earlier constrained investor buying. Investors took a more positive view on US economic conditions when the war began on the assumption that the conflict would prove relatively brief conflict – an assumption that proved correct.

President Obama is likely to be viewed as a catalyst for change and a break with the past, potentially boosting investor as well as consumer and business confidence.


Disinflation refers to slowing rates of inflation, while deflation refers to falling prices. A period of weaker economic growth is likely to lead to one of these factors holding sway, the $64 question is which one. Given that a deflationary environment tends to be associated with weak economic growth or contracting activity, disinflation is clearly preferable.

Interestingly deflation was a concern in the US in 2002 and 2003 when the economy was emerging from recession but the concern receded from view with stronger economic growth in 2004. Inflation was a concern for the US central bank as it was for other central banks through most of 2008 as oil prices soared. But again the concern has shifted to deflation as economic growth slowed in the second half of 2008.

The reflationary policies of major global economies are expected to be successful in ensuring consumer prices continue to grow over 2009, but at a more slower, more sustainable pace than in 2008.

Rising unemployment

If there is one factor to fear in 2009 it is rising unemployment. Job losses translate to slower spending and reduced business income, in turn feeding back into further job losses (“vicious circle”). In the current US recession so far, unemployment has risen from lows of 4.4 per cent to 6.7 per cent. In the previous recession in 2001, unemployment rose from 3.8 per cent to 6.3 per cent.

While US unemployment has generally risen by 2.5-3 percentage points in past recessions, in the 1979-82 experience the jobless rate rose from 5.6 per cent to 10.8 per cent. Still that experience was associated with the peak of baby boomers hitting the job market whereas 2008/09 is characterised by an historically lower share of younger workers.

In Australia, the unemployment rate has only risen modestly so far from a 33-year low of 3.9 per cent in February 2008 to 4.4 per cent in November. Just like the US, the share of young people in the working age population is low – hitting record lows in June. At the same time, migrant workers remain in demand to meet skill shortages.

Overall CommSec expects Australia’s unemployment rate to rise to around 5.25 per cent over 2009. However the risk is that businesses make knee-jerk decisions to trim staff numbers – a development that could spark a mild version of the “vicious circle” noted above. But a sharp rise in the jobless rate is not contemplated.

Monetary policy

Across the globe, official central bank interest rates are at historically-low levels. As a result, questions are being raised about the future effectiveness of monetary policy. However the US is following the same route that Japan took in 2001 in applying “quantitative easing” – effectively buying securities from financial institutions in exchange for cash. The US Federal Reserve chairman Ben Bernanke has also outlined a raft of other measures that could be used to expand liquidity such as offering fixed-term loans to banks at zero interest rates.

While other central banks have much further to go before approaching zero policy rates, clearly there will much discussion and thought applied to alternative monetary policy tools during 2009. In Australia, the cash rate stands at 4.25 per cent and CommSec expects the Reserve Bank to cut rates another 50 basis points (half a percent) to 3.75 per cent in February.

It won’t just be monetary policy tools in the spotlight over 2009 but also monetary policy frameworks. Most central banks use inflation as a guide for monetary policy actions but some policymakers believe that prices of assets like shares and houses should play a greater role in decision-making. For instance if house prices are booming as a result of strong demand, but inflation is still entrenched at lower levels, are central banks right to do nothing?

Other issues to watch in 2009

The Federal Government has recently released its emissions trading White Paper with a proposed implementation date on July 2010. So while the discussion/debate on climate change policies has begun, clearly the issue will feature prominently in 2009. Investors will need to assess the impact on individual companies and industry sectors. Businesses will need to determine the impact on their costs and whether any strategic response is necessary. Consumers won’t have to worry too much about carbon trading over 2009, especially as the Government is planning significant compensation. Still, the issue will generate plenty of debate with the uncertainty potentially affecting confidence levels.

The speed and the extent of contagion flowing from the Global Financial Crisis surprised all and sundry in 2008. However while 2008 was notable for the crisis, 2009 will be notable for the post-mortem. Regulators, governments, central banks and financial institutions will need to work out what went wrong and how it can be prevented from recurring. As is common with previous financial crises, attention will centre on the adequacy of financial regulation. G20 countries have to report by March 31 2009 on a raft of issues associated with financial regulation. Greater international co-operation is essential to prevent a repeat of the current crisis.

The chief risk is that regulators over-compensate by tightening regulation significantly, although we do acknowledge there is a need for greater transparency in some areas, especially in terms of operation of hedge funds.

No doubt the debate on short selling will continue sell into 2009. The proponents of short selling still have not convincingly argued why the practice should be maintained. And as a result, regulators will remain poised to ban the practice. There are too many risks of manipulation associated with the practice as many Australian companies can attest.

China will continue to occupy a prominent position on radar screens in 2009. Over 2008, it was the ascent of China that dominated in the first half of the year with its solid expansion driving commodity prices to record highs. However post-Olympics it has been the global-induced slowdown in China that has raised concern, especially as it has been a fundamental driver of global growth in recent years.

We expect that recent efforts to stimulate the Chinese economy will be successful in 2009. The key factor complicating analysis at present is that economic data has been deflated by the factory shutdown at the time of the Olympics, suggesting that the Chinese economy is weaker than it otherwise is. Substantially firmer readings for key variables like production and fixed asset investment will be sighted around mid 2009.

China remains on course to pass the United States as the largest economy over the next 5-10 years, especially with growth in the US likely to hold near 1-2 per cent over 2008 and 2009.